In a new report from Nanex, which is a market research and data firm, suggests that high frequency traders are pushing the limits of the ticker tape to the tune of one million orders per second or more. This doesn’t sound like a big deal until you understand what is really going on.
This is known as “quote stuffing” where these orders to buy and sell are entered into the system. So, for instance, you put in an order to buy a stock at a given price. Your order is put into the system and is electronically matched with a seller and the trade is executed. The trade is normally placed around the “best bid and offer” on the system. Think about the stock market as a giant arena with buyers on one side and sellers on another and someone in the middle of the arena matching up the buyers and sellers. This works terrifically well in most instances where there are “real” buy and sell orders.
In the world of High Frequency Trading these buy and sell orders are entered by computers, but they are not real orders to buy or sell, they are fictitious orders (hence the term “quote stuffing”) placed in an attempt to slow down the prices seen by regular investors on their financial systems or websites, and profit off the nearly real-time prices the high-frequency firms receive from direct feeds set up through exchange-server farms, that are located directly or close to the floor of the exchange.
Here is where it gets interesting. On July 5th, the capacity for consolidated quote system (CQS) was increased by 33 percent to one million quotes per second. It is by no coincidence that the trading activity rate reached that limit on the very same day as reported by Nanex.
“If three years ago someone told us that equity quote traffic rates for NYSE, AMEX and ARCA issues would exceed one million/second (not even counting Nasdaq stocks), we would have thought the market would have entered the greatest bull or bear market ever known,” the report states. “Instead, you can’t even recognize from a one-minute chart where these bursts of out-of-control quote traffic rates occur. And when they do occur, a significant percentage of those quotes will have already expired before they even leave the exchange network.”
Sal Arnuk of Themis Trading believes he knows where those trades are coming from: The secretive high-speed hedge funds that pay the exchanges well for the privilege of having direct feeds into the exchange through trading hubs like the one for the NYSE in Mahwah, N.J.
“Firms know that if they send enough quotes, it slows down the tape,” said Arnuk. The firms can then fill a retail order based on the slower public quote, while it simultaneously trades on information it gathers essentially milliseconds into the future through its faster direct feeds, said the market infrastructure expert who advised the SEC after last year’s infamous “flash crash.”
“At these rates of growth, we will no longer have a diversity of trading participants with accurate market data, and regulators will have no hope of ever piecing together what happened after the next disaster,” stated the Nanex report. “It took the SEC five months just to assemble equity data to analyze the flash crash. When the next disaster strikes, they will have to contend with 5 to 10 times more data.”
Program trading accounts for as much as 70 percent of the market volume on a daily basis. While not all of the volume is nefarious it certainly goes a long way to explaining why the average investor really doesn’t have a snowball’s chance to out maneuver the hedge funds and HFT firms on the street. Wall Street has been allowed, by the SEC and with the assistance of the exchanges themselves, to set up a system whereby the average retail investor is the sheep set for shearing on a regular basis. It isn’t a wonder that the number of retail investors is slowly dwindling away and someday in the not too distant future Wall Street will be taken over by SkyNet and the firms can trade between themselves as they will have removed all of the capital from Main Street.